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Oct 1989

Futureworld tax: fearful issues and novel answers. (Wide World of Accountancy)

by Manna, John S.

    Abstract- The future of the taxation process will include: the administration of compliance through computers; return-free filings on the federal and state levels; and the electronic filing of tax returns. The increasing use of electronic technology for the filing of income tax and the monitoring of compliance will lead to legal issues dealing with intrusions into privacy. The future technological innovations will have to meet Constitutional requirements of fairness and the question of whether the methods that will be used for future tax enforcement will be allowed under extant tax laws and regulations.

In 1984, one of our co-authors made a prognostication of what the future holds for the tax practitioner of the next century. At that time, it seemed many things predicted were at least 10 to 20 years off, but in five short years the advancements made in computer technology, and the acceptance of this technology, have fulfilled even the most remote predictions. With the pace of change in today's world, some may consider it risky to assess the impact such changes will have.

Before entering the speculative world we call Futureworld tax, we must comprehend the rationale and the legitimacy of our tax system.

Adam Smith stated in "The Wealth of Nations" the rules of rationality for a tax system. He set down four canons: 1) taxes should be equitable based on a citizen's ability to pay; 2) they should be certain and not arbitrary; 3) they should be convenient (that is, clear and plain to the taxpayer); and 4) economical (as little as possible taken). Unfortunately, only the first of these canons has been adhered to in modern times. And even it seems to be under attack. AMT, no separate capital gains rates, and a reduced number of tax brackets have altered the progressive nature of the system.

Assuming that taxation is necessary to provide funding for the government, the question still looms as to what form taxation should take and how onerous it should be. While politicians claim their advocacy for a "fair" tax system, this goal, however sincere, seems to be Utopian. A small fraction of our nation's taxpayers control the majority of its wealth, and yet it does not appear that those same people pay a majority of the taxes.

Our tax system is unconscionably complex, partially because of the process in which it is changed and the administration of the tax itself. Working within the framework of "no new taxes" while trying to close a budget deficit, makes designing a proportionate and equitable tax system extremely difficult, if not impossible. use of Computers to Administer Tax Compliance

Computer applications of all sorts are having a significant impact on our tax system. Faster and more powerful computers now enable the IRS to compare 99% of 1099s and W-2s to individual returns. Four years ago, only 48% of the forms could be so compared. As a result of expanding computer-based reporting, each of us is subject to having all kinds of information electronically reported to the IRS. Wages, miscellaneous income, dividends, interest income, barter income, pension income, social-security payments, as well as reports of sales of capital assets and real property transactions, are being directly reported. Reporting requirements regarding real estate transactions by third parties have been extended from those related to family structures to include other residential, commercial and industrial buildings and unimproved land. No More Tax Returns for Some

It does not take a tremendous leap of imagination to see how return- free tax filing is the next step. While the IRS is cognizant of the confidentiality of information it obtains from taxpayers, there are multiple information-sharing agreements among the IRS and state and local governments. Since many state and local systems mirror or piggy- back the federal system, this sharing could lead to the possibility of return-free filings on these levels also.

Some changes may be needed to perfect such a system. A return-free system involves the aggregation of pertinent data from third parties, such as employers, banks and other financial institutions in the IRS's computer, which would then calculate the taxes due. This system presupposes that only standard deductions could be used. The plan would relieve taxpayers of the burden of filing by having them submit a postcard if they want to participate. They would then be given the opportunity to verify the IRS tax calculation and notify the IRS of discrepancies or disagreements. The concept is intriguing, but it can effectively grant the government a blank check. Many taxpayers would not know enough to question or challenge the government-determined tax under this system. They will be at the mercy of the IRS's computer and the adequacy of the information it gathers. Electronic Filing of Taxpayer Prepared Returns

Electronic filing of tax returns is now available to taxpayers expecting a refund. It is expected to be expanded to reach 40% of taxpayers, or as many as 30 million couples and individuals. The goals of the system are to reduce the paperwork required; save money in terms of processing, storage and retrieval costs; and speed up refunds. Experience so far has indicated that a relatively low percentage of eligible persons have utilized the system, but that could change overnight. The part electronics will play in tax filings can readily be seen. However, is it a step in the right direction? Whatever the answer, it probably is inevitable. Streamlining and Enforcing Compliance

While the gatherings of third party information by the IRS can lead to a system that is more accurate, economical and convenient, man questions remain unanswered. We can expect that the people for whom income information is reported will pay tax on that income. The unanswered question is whether those same people would be forthcoming about reporting income not so gathered. And this system does nothing to subject to tax the vast underground economy that, out of fairness," should pay its share. Third parties will not be interested in reporting the cash payments that presently are made under the table."

Essentially (at least for now), the tax system relies on voluntary compliance, but according to the government's own figures, the level of compliance is deteriorating rapidly.

According to a former commissioner, Donald Alexander, "The truth is that we have such a limited budget and such limited manpower to enforce the income tax laws and collect tax revenue, that the only way we can keep them honest and paying their taxes is to keep them afraid." The system for keeping taxpayers afraid consists primarily of penalties, although the threat of civil and criminal prosecution remains. Since the system of penalties is muddled, applied inconsistently, and regarded as the least fair and least productive method of encouraging compliance, a task force to analyze both the penalties and the complaints about them was established a few years ago. In june 1988, the task force presented its initial draft of a report to a group of advisory tax experts. The task force recommended the elimination of inappropriate objectives of penalties such as revenue raising, punishment, or financing the IRS. Instead, it identified only one aim for penalties, that of promoting and enhancing voluntary compliance.

Whatever their purposes, penalties have resulted in substantial revenue production. In 1986, 18.6 million net penalties were assessed, resulting after abatements in $4 billion revenue. In 1987, the number of net penalties assessed increased to 23 million with a corresponding 150% increase in revenue totalling nearly $10 billion!

Goals of the task force have included judging whether a penalty is fair, simple, administrable and effective in improving compliance. Penalties should rationally relate to the faults, treat violations consistently and not be unnecessarily severe. Another concern is how to handle taxpayers who attempt to comply but inadvertently commit errors which could invoke penalties. In any event, the end result will be penalty reform, probably sometime in 1989. Again, in changing the penalty system, the overriding consideration seems to be revenue neutrality. Fairness without disruption of revenue flow. Is Congress capable of that? Electronic Eavesdropping

The ability to send financial data over the telephone has been with us since the invention of the telephone. When wiretapping abuse surfaced, society recognized the intrusion on private lives and legislated regulations against such abuses. To intrude on someone's conversation, one had to physically splice the wire to hear and record the exchange. Today, with microwave transmissions, there are no wires, and interception of the signal is possible. Therefore, it may be relatively easy to access a wide variety of data without being detected. At this point, one can safely say that the transmission of data through any electronic media has become neither secure nor private.

Administration of taxation naturally lends itself to intrusions into the privacy of financial affairs in the name of enforcement. If the technology exists to gather data, who is to say to what lengths bureaucrats will go in the name of the law and the public interest. Accordingly, the issue of "privacy" in the tax system must be addressed. The question remains: Is a system of taxation rational if it functions at the expense of privacy; and is the sacrificing of privacy the sacrificing of a portion of personal freedom?

There is an incredible capability for surveillance today. Our national intelligence forces freely admit that surveillance equipment is sophisticated enough to determine what the General Secretary of the USSR or the President of the U.S. ate for lunch. Surveillance has been used by taxing authorities in compliance auditing to gather evidence of unreported income. The technology now lends itself to compiling more concrete evidential matter. Coupling this with the ability to compile data from wireless transmissions creates the unique ability to establish and compile evidence that may be very accurate and reliable. In the same breath, however, the data could be as false and circumstantially fabricated as a stacked deck of cards. Ironically the ability to extract tax payments from those not volunteering to report can lead to abuse of the rights of people who report and pay taxes on all their income. A tax system could become so complex that compliance administration becomes dependent on these investigative tools. The level of compliance will significantly improve, but at the expense of privacy and individual freedom.

The IRS can only audit a small percentage of the returns filed. This does not help the self-regulatory nature of the system or pose any significant threat to those outside the system. In 1986 the IRS audited 1.1%, and in 1987 only 1%, of the returns filed. Since, by a commissioner's own admission, "fear" is the only method of enforcing voluntary compliance, the extremes that some agents go to may be overzealous. Fortunately, Congress has become somewhat concerned with complaints from taxpayers. The Taxpayer's Bill of Rights is now in place. The purpose of this document is to place fair and rational limitations on the power of the IRS, preventing potential abuses. Legal issues

The legal foundations of the federal income tax system provide significant insight into the potential future directions of federal tax law and the procedures called Futureworld tax. These foundations indicate which taxes and procedures are acceptable and which are in that gray area yet to be determined.

The decisions of the Supreme Court leave Americans with a Constitutionally unassailable federal income tax. There is no chance that Congress will abolish it voluntarily. The power to tax is fundamental to operating a large government. In 1987, the IRS collected $416.6 billion from individual income taxes and $80.4 billion from corporate income taxes.

One might ask whether Constitutional and legal issues will still be relevant to Futureworld tax. Yet, both categories remain crucial to the future of federal income taxation. Constitutional issues frequently arise since the elements and application of federal income tax laws must meet "fairness" and other Constitutional requirements. Legal issues arise with even greater frequency since the meaning of Constitutional laws and regulations are often ambiguous. Other legal questions arise, such as whether the methods and manner used for tax enforcement are allowed under a specific law or regulation. In fact it is these legal issues that will assure that Futureworld tax does not get out of control. The issues of "Due Process," "Equal Protection," Fairness," and "Right of Privacy" will serve to protect, if we remain alert and conscious to the pressures and advances of a highly technological environment. "Beam me up Scotty" should apply to advanced forms of travel and not the collection of taxes. Conclusion

The IRS has a monumental responsibility, and has met its responsibility with remarkable effectiveness over the years. Technology will assist that agency in the future in new and unanticipated ways. The Constitution and laws of the U.S. are here to protect the taxpayers from inadvertent, unsuspecting, and even intentional intrusion into the taxpayers' lives. We should not expect, or rely upon, the IRS to be the overseer of taxpayers' rights. This requires an objectivity which the IRS should not be expected to possess.




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